lechatnoir/E+ via Getty Images

lechatnoir/E+ via Getty Images

Costco Wholesale Corporation (NASDAQ:COST ), and BJ's Wholesale Club Holdings, Inc (NYSE:BJ ) are two US-based operators of warehouse clubs that offer their members a diverse range of merchandise goods at relatively low prices. Even though they operate in the same industry, there are plenty of differences between the two.

BJ's operations are strictly limited to the US markets (with a bias towards the east coast), where it operates 227 warehouse clubs and 159 gas stations. Its annual revenues are around the $16-$17bn mark, which would give it a market share of 7-8% of the $236bn valued US warehouse club market (Source: Warehouse Club Intelligence Center).

COST is more geographically spread out (located in 46 American states, whereas BJ's is only located in 17), and whilst the US is still its largest market, accounting for 69% of the company's total warehouses, it also has operations in Canada, Mexico, Puerto Rico, Japan, China, UK, Korea, Taiwan, France, Australia, and Spain. Within the US market, it is the dominant entity, with a market share of around 60%. Costco's annual group revenues are also well over the $200bn mark, which gives you a sense of the size of the company.

Both companies offer annual membership plans, and the texture and contribution of these plans to both companies' fortunes are relatively different. Costco's basic membership plans are priced at $60 a year, whilst its premium executive plan is priced at $120 a year; BJ's is a tad cheaper, with the base level plan coming in at $55 a year, and the premium plan priced at $110 a year. What also works in Costco's favor is that it has managed to tie up a larger proportion of its members with the premium plan. Currently, 43% of Costco's members are executive members, whereas, with BJ's, only 35% of its members have signed up for the premium Perk's program.

Prima facie, with an approximate contribution of only 2% of group revenue (for both companies), one could be excused for playing down the membership fee component, but it would foolish to do so. Unlike the core retail operations where margins are remarkably low, these membership fees have no costs associated with them, and thus the flow-through to the operating profit level, and the net profit level can be quite pronounced, particularly with regards to BJ's Wholesale Club. According to data from the most recent quarter, these fees accounted for 64% of BJ's operating profit, and a whopping 86% of its net profit. With COST, the impact of fees on the bottom line is no doubt sizeable, but not as much as BJ's, which makes the operating model of the former, relatively more well-rounded.

Another key differentiating factor between these two companies is their SKU (Stock Keeping Unit) strategy, and this no doubt plays an important role in how effectively inventory is managed. Amongst all the warehouse club members in the US market, BJ's is believed to carry the most items- anything between 5500- 7000 SKUs, yet the diversity in categories is somewhat limited; COST is more efficient in this regard, carrying less than 4000 SKUs which appear to be rather well spread out. BJ's appears to have realized that their strategy isn't quite working out, and they've recently made a conscious decision to reduce the number of SKUs in certain terrains whilst expanding towards other categories. Nonetheless, over the years, COST has come across as a more competent entity in managing and clearing its inventory; currently, the days held in inventory (DIO) are closer to 28 days, whilst it is around 33 days for BJ.

COST's capital position too is a lot more comforting; whilst it currently has around $9bn worth of debt (including capital leases), it also has a lot more cash (over $11.1bn), resulting in a net cash position of $2.8bn. Whilst BJ's should be commended for reducing its long-term debt over time from $2.5bn in FY18 to $0.7bn, its level of capital leases continues to trend up every year and is currently well over $2.1bn. The cash position too is rather minuscule at only $38m, resulting in a sizeable net debt (including capital leases) figure of over $3bn.

COST's superior capital position also provides it with a comforting foundation to distribute dividends. Whilst the current yield may be a pittance at 0.66%, it is still better than nothing (BJ doesn't pay any dividends), and COST has been distributing dividends since 2004 (growing at a CAGR of 13%).

In the most recently concluded quarter, both companies posted solid net sales growth of 16% YoY, and one common theme was the appetite for gas gallons which also helped drive traffic to the stores. I'm not sure this will be a major driver going forward. Since peaking in mid-June at levels of $5.02, average gas prices per gallon have come off by 7% and look to be following a descending trajectory. This does not necessarily have to be a bad thing as a lower proportion of gas sales (where margins are razor thin) in the overall sales mix, could provide a fillip to both companies' gross margins.

Inflation continues to be a major bugbear for both these firms and because they are value plays, it is not ideal for them to pass on these costs. BJ mentioned that cost inflation had been increasing on a sequential basis every month and both companies highlighted an approximate impact of 7% in the most recent quarter. I suspect we may see another quarter of mid-to-high single-digit inflation before things level off. All in all, expect pressures on the merchandise margin to persist in the upcoming quarter as well; just for some context, the merchandise margin (which does not include gas), was down by 30bps for BJ and 46bps for COST in the recently reported quarters.

I'm not sure if BJ will follow suit, but COST also looks poised to hike its annual membership fees soon enough. Whilst there is no official confirmation of the same, and the management appears to be reluctant to pursue it in a high-inflationary environment, I believe we will see it come through before the end of the year. Previously they've raised it every 5.5 years, and Dec 2022 would coincide with that 5.5 mark so expect some updates before that.

There's also a fairly resplendent buyback angle to consider for both stocks which could be instrumental in providing some support to the respective share prices. Costco's $4bn buyback program which commenced in April 2019, will be wrapped up in another eight months; as things stand, the company still has the authority to repurchase shares to the tune of$2.99b n. That figure represents around 1.3% of the current market cap. Nothing hugely exciting, but still somewhat useful.

With the BJ stock, the buyback narrative is a lot more enticing but this will be spread out over a longer duration as their most recent $500m buyback program was only initiated in Nov 2021, and can be carried on till Jan 2025. As per the most recent data, BJ still had about$435m to spend, which represents close to 5% of the current market cap.

Taking a longer-term approach (over the next 2 years), it appears as though BJ will witness faster topline growth, but COST will experience better operating leverage and flow through. According to the YCharts estimates, over the next two fiscals, Costco's revenue could grow at a CAGR of 7.3%, whilst its bottom line will grow at a much superior pace of 11% (differential of 1.49x). With BJ, its bottom line growth is expected to lag the topline growth by 6bps (2-year Revenue CAGR of 8.61%, and EPS CAGR of 8.55%).

Prima facie, with inflation where it is and deteriorating consumer finances, I can see the merit in owning these value-conscious wholesale membership clubs. As you may have gleaned from what I've written so far, it also appears as though COST comes across as a more well-rounded option. However, at current levels, I wouldn't be too enthused about building fresh positions in either COST or BJ, given the technical and valuation backdrops of both these stocks.

With the Costco stock, we can see that the momentum is currently with the bears as the stock had broken down from its ascending channel in May, and the small candles in the following months of June and July have reflected the lack of conviction amongst the bulls; if anything, this looks like a bearish pullback (so far).

In addition to that, if you compare COST to other staple stocks, as represented by the Vanguard Consumer Staples ETF (VDC), you can see that this ratio is trading above its mid-point (2.25) and doesn't offer great risk-reward.

With BJ stock, the risk-reward dynamics are even less appealing. The BJ: VDC ratio is well above its mid-point and at rather elevated levels.

Then, on the standalone BJ chart, we can see that it has been chopping around within the $50-$75 range for close to a year now, and is now making yet another attempt to retest and break lifetime highs (only 7% away from the landmark). This is hardly the best point to get on board as the risk-reward here is quite weak; the more preferable entry point would have been closer to the $50 levels which represents the lower end of the congestion zone we've now seen for the last 12 months.

You're also unlikely to get much value at current levels as both stocks are trading above their average long-term forward earnings multiples. YCharts consensus estimates for BJ's annual Jan 2024 EPS point to a figure of$3.6. At the current price point that represents a forward P/E of 18.74x, a premium of 16% over the stock's long-term forward P/E average of 16.3x.

With Costco, the consensus EPS figure for FY Aug 2023 is $ 14.43, translating to a forward P/E of 34.6, which represents a 9% premium over its long-term average.

To wrap up, the Costco and BJ stocks are both HOLDs.

This article was written by

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.